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Liang Chen
Steven Chen
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Buffettology’s Three Categories of Moats

Our thoughts and picks

Inspired by “super investor” Warren Buffett (Trades, Portfolio) and his mentor Benjamin Graham, Keith Ashworth-Lord started his U.K. Buffettology fund, which has consistently outperformed the benchmark and most of its peers.

The founder of Sanford DeLand Asset Management has quite a simple approach – it starts with looking for high-cash-return businesses that have an economic moat and that are easy to understand and predict. Ashworth-Lord likes to apply the following three categories to identify a moat:

Human capital

One example of Ashworth-Lord’s holdings is RWS Holdings (LSE:RWS), a provider of intellectual property translation, filing and search servicesmand technical and commercial translation and localization:

“The guys at RWS are just people who are dual-qualified, so they will be specialists in something like pharmacy, engineering or software, and they will also be qualified as a linguist. No one else is doing this. Its clients are all big multi-nationals like Siemens, Sony and Microsoft who outsource this activity to RWS, which is number-one in the world.”

Patented or non-patented technology

Ashworth-Lord thinks that Rotork (LSE:ROR), which manufactures industrial flow control equipment, and Bioventix (LSE:BVXP), which supplies sheep monoclonal antibodies fall into this category.

Owning a piece of the customer’s mind

Ashworth-Lord’s favorite example here is Games Workshop (LSE:GAW), a miniature wargame manufacturer, which has been one of his top holdings for many years now:

“The people who play that would spend their last dime on it. They would find a way to play it if they were 100ft underground.”

Well-moated businesses are scarce, in our view. The Buffettology Fund mostly concentrates on the UK stock market, which limits the scope for Ashworth-Lord and could cause some compromise on quality.

Additionally, while the specialized “human capital” indeed plays a critical role in developing the competitive advantage, we believe that it is mainly the business reputation earned through decades of leveraging the skill set to deliver customer value that really helps the company to sustain the advantage. Some of the leading consulting firms may fall into this category as they attempt to dig out a moat based on expertise. One example that comes to mind for us is Exponent (NASDAQ:EXPO), which provides failure analysis services for clients typically in the crisis mode.

Also, we feel that the technological advantage alone, even with patent protection, is a weak guardian for the super-normal return of a business over the long run. Most technology providers rely on high switching cost to fend off competition. Bioventix, Ashworth-Lord’s other top holding, appears to be a perfect example of this. Although we have to admit that the team does have its edge in the niche of high-affinity sheep monoclonal antibodies, there is no guarantee that it can maintain its technological leadership in the long term. Nonetheless, a lengthy regulatory approval leads to one layer of high switching cost for its customers that develops blood tests, and the expensive diagnostic machine that these customers make just leads to another layer. Hence, we feel investors should be confident that the downside of Bioventix is largely protected.

Lastly, we do like Games Workshop because of its unique IP and highly-loyal fan base. At the same time, we also consider the Lindy Effect when it comes to gauging a mindshare-based moat. In this category, our first choice usually goes to century-old brands such as Jack Daniel’s by Brown-Forman (NYSE:BF.A) (NYSE:BF.B).

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Bioventix and Hermes International.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital).

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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